Did SFAS 131 (Segment Disclosures) work?

During today’s Research Office Hours, Christine Botosan, Susan McMahon, and Mary Stanford shared insights from their recent working paper “Representationally Faithful Disclosures, Organizational Design, and Managers’ Segment Reporting Decisions.” In their paper, they investigate whether SFAS 131 had its intended effect — providing users with better information about segment disclosures by encouraging more disaggregated segment information organized along the same groups used by management to manage the business. Christine’s slides are posted here.

They described a novel approach that draws on research in management to develop expectations about firms’ optimal organizational design and find evidence that supports the claim that SFAS 131 improved the correspondence between firms’ internal organizational structures and the segments reported in their financial statements, consistent with the “management view” intended in the FASB standard.

Given that the “management view” is invoked in the FASB’s Financial Statement Presentation Project for purposes of classifying activities, this research is potentially useful in foreshadowing how firms might respond in the context of that proposed standard.

Ray Pfeiffer

Ray Pfeiffer is Professor of Accounting and chair of the accounting department at the Neeley School of Business at TCU Since July 2009. He was the FASB Research Fellow from July 2008 through June 2009 and prior to that was a Professor at the University of Massachusetts. His primary teaching and research interests lie in financial reporting, specifically issues concerning capital market participants' use of financial accounting information, and financial reporting regulation.

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3 comments on “Did SFAS 131 (Segment Disclosures) work?”

This paper caught my attention because of the great emphasis that the Financial Statement presentation project places on the ‘management view.’ My take-away from the paper is that the firms that did change segments in response to 131 did seem to choose more distinct segments. But there are still a few open questions:

1. Are those segments really more like the “true” segments the firms had. I suppose there is no way to know.

2. Are the changed segments actually more informative? Several people suggested trying to tie the changes to more accurate earnings forecasts and the like.

3. What about the firms that didn’t change? Some may have simply had better segments pre-131, while others may have simply not responded to 131 as they should have. Overall, the latter seems to be the case, given the data. It would be interesting to see whether firms with strong corporate governance were more likely to change, or it not, more likely to have better segment reporting before 131 than those with weaker governance.

Finally, what can we take away to Financial Statement Presentation? My concern is that firms typically create segment structures within their firms, for internal reporting and management, so it isn’t hard for management to incorporate that into their external reporting. But firms typically don’t have a formal way to distinguish between operating, investing and financing items, or to identify what detail about the function and nature of expenses is most relevant to users. So management view may be far less successful for FSP than for 131.

The last point that Rob makes is interesting, and it makes me wonder what effects the FSP project could have on the way managers structure their firms.

Presumably, firms follow some optimal structure, but that optimal structure might be conditional on the information available. If a new standard required firms to classify assets and liabilities in a different way (e.g., with respect to operating, investing, and financing activities), could that new classification system influence the way in which managers view their own firm and, perhaps, influence how firms come to be structured in the future?

My sense is that rational theory would say no (managers shouldn’t need a standard to tell them what information they need or how they should think about their firm’s activities), but the reality might be that it would have an effect.

Rob makes some excellent points, which added to those we received during the Second Life session, have given Sue, Mary and I some excellent food for thought. On the first point, I think if you buy the theory in the strategy literature about how firms organize their operations to maximize firm value, and are willing to assume that, on average, managers have a profit maximization motive, then our evidence suggests that more related segments means they are more like the true segments they have. If you don’t buy the theory and/or our assumption, then this is a hard sell. With respect to the second point, we got some excellent suggestions during the session, and plan to pursue these in the next draft of the paper. We also left the session with some new ideas on how to get more mileage out of the no-change versus the change firms, and are in the process of implementing some of these ideas. In summary, we thoroughly enjoyed participating in the session, and the feedback we received will push the project forward in a meaningful way. Thanks to all who participated.

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